How can Loans Affect your Credit Score?

Loans have become a common part of our life, more than we could ever have imagined. You will find the loan for anything and everything today. Be it a housing loan, a car loan, education loan, personal loan, business loans and the list can go on. Traditionally loans were believed to be taken by those who was financially incapable, but in the modern times loans are taken financial security. Business schools actually teach the reason is you have money, taking a part of the amount in loan is a financially smart decision. However, many people worry that taking loan may affect your credit score.

Before answering that, there are many people don’t even understand the concept of credit scores. So what exactly is a credit score? A credit score is a numerical value that represents analysis of a person’s credit files. It’s basically the credit worthiness of an individual. It is based on the credit report given by credit bureaus. It includes everything, from cheque bounces, credit card payment default, loan default, EMI default and to everything that is related to your finances. The lower the credit score the left creditworthy you are. Credit scores are generally checked by bankers before giving you loans, while buying cars, houses, new credit card, or any other high value item. The credit score ranges from 300 to 900, in india.

Now that we understand what a credit score is, effect your credit score. Contrary to popular belief, loans can actually help improve your credit score , provided you pay all the installments on time.

If you have taken any sort of loans in the past and have paid them on time, creditors in the future will look at your past creditworthiness and we’ll actually be willing to give you alone in the time of need.

If you have, for any reason, built up A poor credit score, you can eventually improve your score by taking loans and repairing them on time. It may take awhile to improve the credit score, but will happen.

Taking on new loans, while already having some, may become difficult. This is because your credit score reflects all the loan you have taken, the timely or untimely installments paid and your entire credit of the past as well as the present. While taking up new loans with pre existing ones, lenders we calculate your debt to income ratio to be able to analyze the payments receivable and the future. This will hamper the amount of loan you get.

The above point will also affect your ability become a guarantor somebody else. Becoming a guarantor means that in case of default from that person taking the loan, you will pay the amount. Hence, the same logic as above applies in this case.

When taking a loan initially, you will see a slight dip in your credit score. However this is a short lived dip, provided you pay your installments on time.

It is not advisable take loans just for the sake of improving your credit score or unless they are absolutely necessary. Remember, 10% of your credit score comes from the number of applications given for the loans. Every time you apply for a loan, where is the credit inquiry that happens. A credit inquiry indicates that you don’t have a very strong financial position. So as the number of inquiries is increase your credit score will be adversely affected.

After taking a loan, make sure that you pay the loan amount along with the interest as soon as possible. This is something we normally tend to do but it is important to remember that this is essential even for your credit score. The higher the loan balance you have remaining, the more adversely it will affect your credit score.

Now that we understand the correlation between loans and credit score, keep in mind that a loan baby long term or short term but your credit score will be with you for life and me also affect spouse and children. The bottom line is, don’t be afraid take a loan just for your credit score. Take a loan when necessary, but make sure you pay it on time. This will actually improve your credit score. Also, don’t forget to help others clarify misunderstandings between the correlation of loans and credit scores.

About Jennifer Cribsly

I'm a former real estate broker who specialized in helping first time buyers be able to purchase a home. Now full time mom, part time real estate owner/investor.